The bank bail-out and Ken Clarke: a risky combination?

The reintroduction of Ken Clarke to the front bench has an obvious logic. Peter Mandelson has not only refreshed Government economic policy but he has also taken the fight directly to the Tories (as George Osborne can testify). The Tories need someone with a bit more oomph than the languid Alan Duncan to respond in the business brief. But, and it’s a big but, today’s bail out of the banks makes this a deeply risky move for Cameron.

Despite the Tories’ opportunistic opposition to state intervention to stave off financial and economic meltdown, it is clear that there is no alternative (to borrow a phrase!) to what the UK Government and governments across the world are doing. We may quibble about the detail of various schemes to save the economy but the sudden global trend towards very significant state intervention is undeniable.

The real issue is how long the financial markets, and in particular the bond market (where the Government raises much of its borrowed funds), will stand the state sinking vast sums into the banks and the wider economy. Once they decide the Government has gone too far, sterling could enter a nosedive as investors seek to escape any association with a financially troubled state. The dilemma for the Government is that it is very difficult to know in advance how far you can push the markets. By the time ministers realise they have pushed too far, it will probably be too late to row back.

At the moment, the markets seem willing to fund the intervention (UPDATE 20/1/09: maybe I spoke too soon!). Standard and Poor recently downgraded the credit standing of some governments (Ireland, Greece and Spain) but not the UK. But as today’s bail-out has shown and as Donald Rumsfeld would say there are a heck of a lot of “known unknowns” and not a few “unknown unknowns” in this economic mess. Some unexpected piece of news, a further wave of loss of investor confidence and another hugely expensive intervention could all too easily get the markets worried about the solvency of the UK state.

If sterling did plummet under such conditions, one obvious solution would be to rapidly join the Euro. Effectively ditching a troubled currency for one enjoying greater confidence. Indeed, Will Hutton argued yesterday that if the Government announced its intention to join the Euro in the near future, it could find it much easier to raise the money it needs without fear of a run on the pound. Of course, there is absolutely no appetite for the Euro in Downing Street at the moment but then there was no appetite for the effective nationalisation of our major banks just a few months ago.

Which brings us back to Ken Clarke. He may say he accepts the settled policy of the Conservative Party on the European Union but that is under conditions of no foreseeable moves on the Euro. I’ve no doubt that if the Government pushed the UK into the Euro under duress and probably without a referendum, it would pay an extremely heavy price in an election. But the Tory attack on the issue could be seriously blunted by division on its front bench. And this could possibly go wider than Clarke versus the rest. After all a choice between an economy devastated by a collapsed pound or joining the Euro may give pause for thought to even the more swivel-eyed eurosceptics. OK, maybe not them, but the less swivel-eyed ones could well take a less hostile line.